National competitiveness and the protectionist race to the bottom

2012-03-27

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The primary objective of European integration ever since its inception was to combat economic nationalism, i.e. protectionism, by establishing a common market that would gradually dismantle all economic barriers, allowing for free trade among member-states. Indeed ever since the official initiation of the European integration process in the 1950s much has been done in eliminating obstacles to trade. This ongoing process has nonetheless been a laborious task, given that a vast legal corpus of Community regulations, directives and decisions, together with ECJ (European Court of Justice) rulings were necessary to price open the once closed national economies of Europe.

Though in our time protectionism within the single market is quite limited, at least in comparison to previous decades, economic nationalism as such never really abandoned Europe, despite the momentum of integration. What once was a patchwork of squabbling nation-states, competing with each other by means of protectionist policies, transformed into a unified economic bloc that transferred protectionism to its external borders. Indeed the EU maintains several policies whose main (covert) function is to obstruct free trade and engage in beggar thy neighbor practices with the rest of the world and especially with China and emerging economies.

This is an approach that makes everyone worse off, by leading us to a suboptimal level of production. Protectionist policies are harmful for two reasons, an internal and an external one:

On their internal dimension, they protect local producers from international competition, by either subsiding their products to make them artificially less expensive, and/or by increasing the costs on imports, so that the two can compete. Protecting local producers from international competition, means that the explicit and implicit costs will ultimately fall on local taxpayers and consumers. Taxpayers are the ones who ultimately finance the subsidies and the necessary bureaus and mechanisms that keep the trade barriers in place; while consumers are faced with limited options in terms of quality and quantity and/or with higher prices, than what would have been the optimal level of choice, quality and price, should no barriers exist. Local producers gain an advantage over local consumers and taxpayers, eventually strengthening their bargaining power, i.e. political influence, that is ultimately exerted on decision-makers to extract even more benefits.

And though protectionist measures might seem beneficial at first sight, in the sense that local businesses and employment positions remain in place, “saved” from the “destructive” forces of international competition, in truth they are harmful for the local economy as the disposable income of consumers diminishes. Had it existed it could otherwise be channeled into savings or investments or even additional consumption. Meanwhile the privileged producers become complacent, by the artificial lack of international competition, making them less productive, innovative and robust.

In a nutshell the local economy is denied much of its potential. The measures that are implemented to protect local production and jobs, actually succeed in destroying jobs and weakening production.

On their external dimension, protectionist measures make the entire population of international competitors worse off (especially of emerging economies). The foreign producers are faced with higher export costs, which means that much of their potential income is lost. If they were not faced with trade barriers they could use that additional profit to save more or invest in modernizing their facilities or in adding it to aggregate savings that could then be used for investments in infrastructure or to boost consumption or in any other productive activity that would eventually raise their standard of living. In short much of the potential income of the exporting economy is lost in efforts to comply with “standards” and red tape. Meanwhile foreign consumers also lose out, since the increased costs for producers of exported goods can be rolled over to them, directly or indirectly, by means of higher prices or fewer employment opportunities, or lower wages and other social benefits. Ultimately this is a replication of the negative effects of protectionism on local consumers and taxpayers.

The moral is that over the longer term everyone is worse off wherever protectionism exists.

National competitiveness

Even though protectionism exists in quite an apparent way, over the last few years, we have developed a new “compelling” notion, to conceal the fact: national competitiveness, i.e. the idea that countries can be competitive or uncompetitive. For instance Greece is considered uncompetitive while Germany is thought to be competitive. Though this concept could make sense, if taken light-heartedly, as a loose expression for the level of education, or technological research, or entrepreneurship, or internal market rigidities and malignancies, pointing to the need for structural reforms and so on; it remains nonetheless a rather problematic idea. The reason is that in the economic sense nations do not compete with each other – only businesses do.

To illustrate the point, Germany is thought to be a very “competitive” economy, yet the German firm in a given industry, say tourism, might be far less competitive than the equivalent Greek, even if Greece as a nation is not “competitive”. Same applies for virtually every single tradable sector on the planet. Nations can only follow two possible courses of action as far as trade is concerned: either cooperate with each other, like the EU in its internal dimension, or hamper each others efforts by means of protectionism. At any rate nations have no “competitiveness” at all, in the strict sense – this notion is in my view a rather misleading abstraction.

The reason such a term has become a standard, especially in post-financial crisis economico-political parlance, has much to do with politics and the subconscious cultivation of “we-they” mentalities. It is convenient for national politicians to praise the “competitiveness” of their country, while it also serves as a handy tool to justify the existence of protectionist policies by claiming that these contribute to the overall “competitiveness” of the country. In light of this, we recently heard the French President and presidential candidate Nikolas Sarkozy elaborating on yet another perverse proposal: the “Buy European Act” whose purpose will be to encourage consumers (or practically force them) to purchase European products instead of their equivalent international ones.

If we as individual European consumers really feel like helping our fellow European producers we can do it by ourselves without some nomenclature coercing us. After all the best way for producers to help themselves is to stand up to international competition by producing cheaper, better and more innovative products that we will buy because they really are good, not because Sarkozy or whoever else thinks it would be good. What regulators really need to be concerned about, is how to help producers reach that point, by removing many of the obstacles they have erected and instead facilitate and encourage the reallocation of resources from non-tradable to tradable areas. Narrow-sighted ideas like those of Sarkozy, if brought into law, will return us back to the times we understood international trade as high politics and used it to grind our “enemies” under our heel, eventually fueling an economic war of attrition. Such nonsense will ultimately do much more harm than good to everyone, including European producers.

Regardless of what the overall economic orientation of the EU may be, free trade with the rest of the world needs to be strengthened, not undermined by narrow-minded convictions. Even though some politicians might present protectionism, or their new favorite expression of “national competitiveness” as a patriotic duty for the sake of saving “us Europeans” from “them”, in truth they are proposing a rot deal that will only put us in a race to the bottom with the rest of the world. There has never been any good coming out of nationalist/protectionist mentalities. I for once believe in free trade and healthy competition between businesses, supported by the cooperation of states. This is what makes everyone better-off, not zero-sum games.

Finally as Charlemagne, the columnist of The Economist, wrote in his recent article on another aspect of the same issue:

Europe needs more competition, not less, to overcome its crisis. If there is a silver lining in the global financial crisis, it is that the world has so far avoided a 1930s-style protectionist war. The EU should not do anything that could provoke another one.</p>